Freight volumes are slowly coming back to trucking market, but it will take a while before volumes in the contract freight market are significant enough to drive higher spot rates. There is a potential capacity shortage by the end of the year, caused by unseated trucks and trucking bankruptcies.
The freight economy has been completely turned upside down by the COVID-19 shutdown. Initially, the industry experienced a massive surge of freight demand in response to demand for consumer packaged goods and groceries.
The build-up to the climax that started on February 21, 2020 took 31 days before it peaked on March 23, 2020. But with much of the economy going into lock-down, the surge was short-term. The drop back to the pre-COVID surge took just 16 days, almost half the time the freight economy experienced elevated volumes.
Elevated volumes stayed higher than their pre-COVID fueled surge for 45 days.
All of this data comes from the FreightWaves SONAR outbound tender volume index (SONAR:OTVI). OTVI is perhaps the most important measurement of the freight economy because it measures contracted freight volumes, which represent approximately 85% of all truckload freight in the market. This data comes from electronic tenders, or load requests sent from shippers to carriers. In other words, OTVI measures actual loads, not search or post activity on a load board.
Unlike the spot market, which experiences far more violent swings on a regular basis, contracted freight stays pretty consistent throughout the year, with the exception of holidays. To see the violent moves in the contract market is telling regarding the current state of the freight economy.
The trucking industry has been searching for the bottom, with a lot of disagreement about when it would come. The bears believe that the worst is still ahead, caused by rapid unemployment, declines in consumer spending, energy market softness, and slowing port activity.
This past week, I suggested that the market bottom was close and that we would see an acceleration in volume over the coming weeks. My reasons were simple, and based on a key point – the economy is about to restart.
I made the call on April 14, 2020, when OTVI was at 8,763. At the time, the drop in freight demand had not stopped, but the slope had. My logic was that the parts of the freight economy that were likely to be shut down had already been and the sentiment had shifted from panic about the virus to people talking about restarting the economy. The drop in OTVI continued for a few days, but ended up finding a bottom at 8,439 on April 16, 2020.
So far this has proven to be the low mark in the index. As I write this on April 24, 2020, the OTVI index sits at 8,690, never retesting the lows.
In fact, on a week-over-week basis, we have seen an increase in trucking freight volumes of 3%. I would suggest that with certain economies starting to open and industrial manufacturing set to come on line in the next two weeks, I think it is safe to assume that the period of volume deterioration is likely behind us. I believe we have hit the bottom.
All of this gives me confidence that the deterioration of freight demand is largely behind us, with the caveat that a second wave of the virus or another major nationwide shutdown could result in damage to industrial activity and freight demand.
The Energy Information Administration’s (EIA) weekly statistical report showed that a proxy figure for distillate demand – most of it diesel – rose 11.8% in the week ended April 17, according to data released by the EIA on Wednesday, April 22. The figure of 3.12 million barrels/day (b/d) was a big jump from the figure reported a week earlier of 2.757 million b/d. The demand figures are under a category the EIA calls “Product Supplied.”
At the same time, the ULSDV.USA data series in SONAR on April 23 was reporting a jump in diesel demand of approximately 13.2% since April 16. The ULSDV records actual volume sold at the wholesale distribution point, known in the industry as the “rack.”
When most people think of freight movement, they think of retail goods. This is largely because they tend to relate to their own personal experience. But non grocery retail is less than a quarter of overall freight demand. Retail volumes have dropped as consumers hunker down, but are expected to come back over time. Even if consumers are uncomfortable with brick and mortar, their spending will move to e-commerce.
The largest segments of our freight economy are tied to energy, agriculture and industrial activity.
Industrial activity has been largely dormant in parts of our economy for the past few weeks. The exception has been in food, consumer packaged goods, and healthcare-related industries. The big industrial drivers of U.S. freight demand – aerospace, metals, textiles, furniture, automotive, building materials, and electronics – have mostly been off-line or have been experiencing reduced capacity.
Energy and agriculture are the two most important industries that drive revenue-ton miles in the freight economy. Agricultural production has not been impacted drastically by COVID-19, although we see some issues in the meat processing plants. The agricultural market, with the exception of the parts that are involved in ethanol production or industrial feedstock, is likely to sustain regardless of broader shutdowns.
It is an easy bet that any industrial activity tied to the oil and natural gas drilling sector of the energy market is unlikely to come back anytime soon. While energy transportation is the largest generator of revenue ton-miles in transportation, much of this goes through other modes, including rail, pipeline and barge. Plus, an estimated 75% of energy-related ton-miles is tied to electricity production in the United States. And power plants are still operating, albeit with slightly reduced demand. Any slowing of power demand in the U.S. is likely to come back as we approach the summer months and industrial activity largely resumes.
The fact is that the industrial sector is what drives much of our freight economy, especially on the truckload side of the world. And here we are about to see a boost.
Automotive and aerospace plants are planning to resume production within the next two weeks and with that action, their suppliers will largely come back on line. This will be followed by other parts of the industrial supply chain in textiles, metals and electronics. Furniture and building materials are largely tied to consumer confidence, which will take some time to come back. The good news is that consumer economic pain is being softened by an unprecedented amount of government stimulus.
The two Paycheck Protection Program (PPP) bills will put as many dollars into the economy over the next three months as the annual U.S. military budget.
While the unemployment numbers are real, the support offered by Federal and state governments will offer more income to those previously employed that made less than $50,000 a year and in some states $60,000 per year. For the vast majority of the people that were laid off, they will be better off financially now than they were before the crisis hit.
While consumer sentiment will continue to struggle until people find hope in a long-term recovery and employment, consumer spending won’t completely dry up. In fact, a large portion of consumer spending was dedicated to parts of the economy that will continue to stay shut, including travel, concerts, sporting events, gym memberships, movie theaters and festivals. In other words, sectors that don’t drive a lot of freight demand.
My view is that freight volumes across the entire market are unlikely to return to their pre-COVID-19 levels for some time. Perhaps a few quarters and maybe only after we have confidence in a treatment or vaccine for COVID-19. Contract volumes, however, largely will come back, even if it takes a quarter or two.
The return of contract freight volumes won’t solve all of the industry’s woes, especially carriers with a large concentration of business tied to the spot market.
Tender rejection rates are likely to stay low for some period of time, as the industry churns through capacity (bankruptcies and market attrition). Tender rejection rates are a very reliable barometer of market capacity. A low tender rejection rate means that carriers are willing to take almost any load offered to them under their contract commitment. A high tender rejection rate means that carriers are being more selective in what loads they take from their contracted commitments. With low tender rejection rates reflecting a soft contract market, freight spot rates will stay low.
Carriers with a larger concentration of freight in the contract market will also experience some economic pain in the market. The best run truckload carriers have spent years creating engineered networks that drive utilization and create operational efficiencies. This helps driver recruitment and retention, while keeping their trucks loaded. Since not every part of the freight market will come back at once and with demand that is different than it was pre-crisis, a truckload carrier may find its network largely broken.
Even if the carrier’s rates stay consistent with those shippers, the fleet’s net revenue per truck per week could be dramatically reduced. The reason is that a carrier’s network is built to maximize net revenue per truck per week, while allowing the carrier to take contract loads at a discount to the market. If volumes from a specific shipper are lower (or even higher) than before, it could disrupt the carrier’s network. A disruption in a fleet’s load per truck per week could be detrimental to its profitability.
Predicting future spot rates will be difficult for those relying only on historic rate data and historic freight market activity analytics. Current market conditions will change rapidly as carriers adapt to this new operating environment and it will be pertinent for carriers to monitor current freight market activity to keep loaded.
As long as freight market trends remain uncertain, truckload carriers will see used commercial truck prices drop, taking any equity in their corporate balance sheet with it. Few will want to make investments in expansion of their fleet or start a new trucking firm. Bankruptcies and shutdowns will increase, lowering the amount of available capacity in the market.
Carriers that operate in the spot market or that have large concentrations in their customer base may find it difficult to keep running or stay afloat. This will keep a lid on small fleet capacity coming back into the market as volume increases, particularly among owner-operators.
But the bigger impact to capacity has to do with the mid-sized and large trucking fleets. With 75%-80% of all for-hire truckload capacity coming from drivers that are employees of fleets rather than owner-operators, the biggest variable in capacity will come from what the driver employment picture looks like.
Government unemployment stimulus will keep a lid on new drivers entering the workforce. If people can make $50,000-60,000 sitting at home enjoying time with the family, they have little incentive to take a job driving a truck that is likely to pay less and create potential exposure to the virus.
An estimated 75% of truck driving schools are currently shut-down across the country. According to Eric Fuller, the CEO of U.S. Xpress, 3,000 students typically graduate from driver training schools each week and as many of 30% of the drivers that quit their first trucking job leave the industry all together.
Fleets recruit thousands of drivers every week from the nation’s driving schools. With those shutdowns due to COVID-19 restrictions, this driver employment source will be shuttered.
While some states will resume their economies, driving schools will likely find that potential students will be in short supply. After all, who wants to sit in close proximity to other students, sharing equipment and sharing a small instructional cab with a trainer? Plus, most students in truck driving schools tend to be people in their 30s and 40s who lose jobs in other industries. The stimulus bill disincentivizes those people to join trucking right now.
So if truck drivers aren’t readily available, then the industry will struggle with unseated trucks. Unseated trucks is a term used to describe trucks that are owned or leased by a fleet, that are parked with no driver available to drive the truck. This will lead to additional bankruptcies and/or driver wage inflation. If driver wages rise faster than freight rates, many more trucking companies will be in trouble.
The largest carriers that enjoy high-volume, consistent contract loads or dedicated fleet contracts will fare much better than most. Those fleets will be able to keep their drivers running and dynamically engineer their freight networks.
The hours of service rules will also likely go back to their original mandates. As drivers become harder to come by and hours available to drive lower, capacity will tighten. After all, the capacity constraint in the market isn’t the total amount of trucks, it’s the amount of hours drivers in aggregate have to drive and be on-duty.
If capacity isn’t coming from the owner-operator community or from new entrants into the industry, where will they come from? Chances are, the industry will have a capacity shortage and those fleets that survived the COVID winter will be a really nice position to benefit.
Shippers will find that outbound freight costs are likely to increase in the contract market, as carriers start to benefit from the massive freight market capacity churn that has taken place. Forward thinking shippers will scramble to secure freight rates in contracts, having seen what a 2018-like scenario could do to their freight budgets.
Shippers that fail to lock in higher contract rates now will end up paying higher than market spot rates. Freight spot rates are likely to rise within the next few months as the freight economy comes back online. This won’t happen until we see volume come back and contract freight market rates have stabilized. When they do, carriers will start to grow their fleets again.
Class 8 truck orders will be slow to respond, even as the trucking market flips to the carriers’ advantage, as there will be plenty of inventory of late model used trucks on the market and new Class 8 truckers in dealer inventory. New commercial truck prices will likely firm in 2021 as excess truck inventory gets sold in the market and the truck manufacturers slowly, but methodically ramp up production, trying not to overshoot new truck demand.
As public activity once again resumes (concerts, sporting events, parties, dining out), employment will also come back in those areas. Construction of new commercial offices and venues (perhaps with more social distancing required) will begin. Jobs in the service economy that compete for the same employee base as the trucking industry will end up driving up driver wages. Driver employment will likely stabilize, but with much higher wages for drivers.
We will also see new consumer demand and activity in the freight economy. Companies will emphasize the importance of domestic sourcing of goods in the interest of supply chain risk management. This will spur new domestic industrial and manufacturing demand, which will create more freight demand. Carriers then will have the opportunity to maximize trucking rates and freight market rates.
If you are interested in the SONAR freight demand forecasting model or tracking tender reject rates, sign up for a SONAR demo. SONAR freight index data includes volume, freight demand, trucking rates, spot rates, contract rates, tender rejection rates, freight detention, and freight market capacity.